National Security and Investment Bill (Second sitting)

(Limited Text - Ministerial Extracts only)

Committee stage & Committee Debate: 2nd sitting: House of Commons
Tuesday 24th November 2020 Public Bill Committees

[Chi Onwurah]

Q Thank you, Dr Lenihan. That is absolutely fascinating. The need for different agencies to be involved needs to be recognised.

In terms of your work on investments, and the investment regime, is there not a risk that it ends up capturing a host of investment transactions? I am particularly thinking of the burden and impact on our innovative tech start-ups. The likely definitions of the sectors to be involved include artificial intelligence and data infrastructure. Based on your experience of other countries’ introduction of new investment screening rules, have you found patterns in how similar changes have affected foreign direct investment, and potential trade deals, which is a topical subject? Do you have any thoughts on ways to mitigate the burden and impact, particularly on start-ups?

Dr Lenihan: The Bill is arguably broader in scope on call-in powers than some other foreign direct investment regimes—I would argue that these perhaps even include the US regime—because it does leave wide latitude for call-in powers. The Bill also covers trigger events that are initiated by all investors, both domestic and foreign, and that is truly rare among Western FDI review regimes that are focused on national security. Usually, the concern is to focus the regime on investments from foreign-owned, controlled or influenced entities. Domestic entities and acquirers that have, for example, ultimate foreign ownership or influence in some ways should be able to be caught by any well-institutionalised and resourced regime. I am not sure why it is that we do not actually see the word “foreign” in the Bill, even though it is supposed to be based on foreign direct investment. Perhaps that is a concern about potential domestic threats down the road, but either way, it will lead to a much larger volume of mandatory notifications than most other national security FDI regimes—the US, Germany, Australia and other countries. Almost 17 have made changes in the past couple of years, and these have increased and been modified since the covid pandemic.

I understand that the legislation may be written as it is to include domestic investors, perhaps to avoid appearing to discriminate against foreign investors. I would suggest that that is probably too broad a formulation for focusing on and identifying real risk. The EU framework for FDI screening encourages its EU members to adopt mechanisms that do not discriminate between third-party countries, but that does not mean that it takes the word “foreign” out of its legislation to target foreign investments as opposed to domestic ones. Part of that is about the volume of transactions.

One thing I would highlight is that FIRRMA expanded the scope of covered transactions to include non-controlling investments of potential concern, as well as any other transaction or arrangement intended to circumvent CFIUS’s jurisdiction. But because it has had more cases to review on a detailed level in the past two or three years than in its history, since 1975, a major element of that Act is, again, around staffing and resources. There is a specific provision in FIRRMA, which is very clear that each of its agencies needs to hire under-secretaries in each agency just to be dedicated to this task.

There are two elements. An inter-agency review team is needed. You need enough staff to actually handle and catch all the risks. You the need the proper resources to do so—the right access to the databases, the right security clearances, the right training. On top of that, the volume of mandatory notifications will be increased by the fact that this is not just focused on foreign investment. I do not think there is much you can do about the foreign cases that you will get. There will be a high volume of those, and you need to be ready for them, but it is an important national security risk that needs to be dealt with.

[The Parliamentary Under-Secretary of State for Business, Energy and Industrial Strategy (Nadhim Zahawi)]

Q It is a pleasure to serve under your chairmanship, Sir Graham. Dr Ashley, considering your experience of other countries—we talked about the US at length in the first couple of questions—such as Japan and Germany, what are your views on the retrospective powers under our Bill?

Dr Lenihan: Personally, I think they are fine. I know that might not be a popular answer with some. Germany, France and even parts of the EU framework set up this five-year retroactive for cases. I think that that is at minimum important. Other countries, such as China, Russia and the US, do not place any limit on retroactivity. I would have to check up on Australia and Canada, but there have been cases that have gone beyond a year there. Under the original Government White Paper, the idea of having only a six-month period, whether or not you have been notified, is quite dangerous, because there have been cases that were well known where they have been caught after that point.

Some of my examples are from the US. The reason for that is that it is one of the longest-standing and most institutionalised regimes. It is also one of the most transparent, from which we know most about the cases that have gone through it. I have looked at over 200 cases of this type of investment over a seven-year period in the US, UK, Europe, China and Russia. One case that stands out in the US is the 3Leaf acquisition by Huawei, which was caught almost at the year mark. Another good example that went over the one-year mark would be the review in 2005 retroactively of Smartmatic, which was a Venezuelan software company, and its purchase of Sequoia Voting Systems, which was a US voting machines firm. Smartmatic was believed to have ties to Chavez. However, that acquisition completed without knowledge of CFIUS and it was not actually able to be unwound until 2007. At that point, you worry about what has happened, but at least you do not have the ongoing concern.

You do need flexibility. With the volume of notifications and the learning curve that the investment security unit will have to undergo, or whatever the final regime truly looks like, it will take time to get the team in place and get the knowledge and systems down, to accurately catch even the most obvious investments that are of concern. Dealing with the kind of evolving and emerging threats we see in terms of novel investments from countries such as China, Russia and Venezuela needs the flexibility to look at retroactively and potentially unwind transactions that the Secretary of State and the investment security unit were not even aware of.

One thing is that for mergers and acquisitions transactions, which are historically what have been covered under these regimes, across Europe, Australia, Canada, Russia, China and the US, all the systems that have been used—the M and A databases: Thomson ONE, Zephyr, Orbis—take training, but they only cover certain types of transaction. They do not cover asset transactions; they do not cover real estate transactions, which are of increasing concern, especially for espionage purposes.

It is going to take time, and I believe that flexibility really needs to be there. It can always be reviewed in the future, but I do not think that so far foreign investment has been deterred in any way in countries that have that retroactive capability. To limit the UK’s capacity to protect itself for some kind of strange feeling that we need to be perceived as being even more open than everybody else when under threat is not really wise at this time.

[Matt Western (Warwick and Leamington) (Lab)]

Q It is a pleasure to serve under your chairmanship, Sir Graham. Dr Lenihan, I am keen to know more about whether, other than in the US, you have seen good exemplar approaches to screening investments into these sectors; we spoke about Japan and Germany a moment ago. Can you give examples which we might learn from?

Dr Lenihan: I do think the US system is the most institutionalised that we have, and the best at the moment. That being said, Germany’s system is very good; it has caught quite a bit. The German system has also been very good about regularly updating, changing and adapting its regulations as it sees new emerging threats to itself. They seem to have good feed-in across Government and they are exceptionally good at co-ordinating with other states in terms of information of concern.

In terms of national security review, Canadian and Australian systems are quite good. The problem with those systems is that they tend to do national interest reviews at the same time or in tandem with their national security reviews. Over the long term, including national interest in the regime has had an impact on how they are perceived in terms of their openness to foreign direct investment abroad. In the OECD’s FDI restrictedness index, Canada and Australia rank far lower than the US, the UK, Germany and France, and I think this is because of their inclusion of national interest concerns. Similarly, on the World Economic Forum’s global competitiveness index, they rank far lower. That does not provide investors with the type of clarity that they need. In general, we see that investors tend not to be dissuaded from investing just because there is a new foreign direct investment regime, as long as that regime is seen to have clear regulatory guidance, is transparent, and is applied consistently over time.

France sometimes gets quite a bad reputation for economic nationalism, but its review mechanism is also quite good at catching potential threats to national security. Japan is an interesting case. It has been so restrictive for so long that it is a little harder to compare with the other western countries. Its system has been tied in again to an overarching inward investment regime that has been restrictive towards foreign investment for other means beyond national security, so I find that country to be less of a comparator for these purposes. I hope that answers the question.

--- Later in debate ---

[Chi Onwurah]

Q To follow up on your point about notifications, the Government impact assessment for the Bill suggests that up to 1,830 notifications might come in each year under this new regime. I am concerned that they look at the impact on the acquirer, and they do not capture the fact that almost every start-up seeks capital investment at some point. What impact do you foresee on the overall UK investment climate, and what might FIRRMA and CFIUS changes lead us to expect in our case?

Michael Leiter: This is very important. I was rather taken aback by two things about the Bill. The first is the projection of over 1,000 matters, going from the very, very few that the UK has traditionally had; this is an explosive increase in matters. I am concerned that no Government are ready for that rate of change. Even in CFIUS under FIRRMA, although there is not an increase in the overall number of long-form notices, in the short-form declaration process, there was an increase. That was relatively modest, an increase of about one third, so the US now reviews approximately 240 full cases, and about another 100 short-form.

When you talk about going from a few dozen to 1,000, you have to be very sure that you have both the resources and the expertise to process that. I would be concerned by that. Another case where your Bill goes much farther than anything I have seen, and certainly much farther than anything in the United States, is in encompassing not just acquisition and investment in businesses but acquisition and investment in supplies, goods, trade secrets, databases, source code and algorithms, so it is tangible and intangible objects, rather than businesses. That scale is very difficult to predict, and if one is more in the mood for incremental change, so as to see how a Government can handle change, including those elements poses some real risk for management.

[Nadhim Zahawi]

Q Thank you, Mr Leiter. That is really good feedback. Building on the point made by my colleague the shadow Minister, the CFIUS regime in the US obviously operates successfully, in the sense that the US remains an incredibly attractive place for inward investment. How have the US regulators balanced those two things? Does the Bill as drafted provide us with a similar opportunity to strike that balance?

Michael Leiter: I am honoured to have worked with the UK Government for 20-plus years on security issues, and over the past 10 years on economic issues. I certainly think you have the potential to strike that balance. In the US, traditionally, the CFIUS structure was a balance between the security agencies, which tended to want to restrict investment, and the economic and commerce agencies, which tended to want to encourage that investment. Certainly, in the case of China, we have seen massive decline in direct investment because of both Chinese controls and US controls: a tenfold decrease from 2016 to 2018. But as you said, the scale and strength of the US economy mean that global investors look to the United States no matter what.

I do not mean to make less of the UK in any way but, from a UK perspective, one has to be a bit more careful, because you simply do not have the scale that inevitably will attract investment. The US could be a rather poor place to invest, with lots of regulation, but people would still come because of the scale of the market. You don’t have quite that luxury. That is not to say that the UK has not for generations been an incredibly attractive magnet for investment, but whereas the US can err on the side of security, from my perspective, admittedly an American one, the UK might want to be a bit more careful about restrictive measures, because the size of the market is not in and of itself so inherently attractive that companies and investors must be in it. We have a bit of an advantage over you on this one.

[Peter Grant (Glenrothes) (SNP)]

Q Good afternoon. I do not know whether your saw much of the previous witness’s evidence, but she commented on how countries such as the United States have a limited number of excluded or exempt countries—including the United Kingdom—that are not covered by their equivalent legislation. What are your thoughts on how the Bill does not have any provision to exempt entire countries from its scope?

Michael Leiter: I was able to see part of Dr Lenihan’s excellent testimony, which was quite informative and good. First, to clarify, although the US does make distinctions for exempted countries—obviously those are the UK, Australia and Canada right now—that exemption is extremely narrow. It limits those countries only on mandatory filings, and only if investors from those countries fulfil a fairly rigorous set of requirements. So, although Canadian, UK and Australian investors were quite excited before CFIUS reform, when the regulations about excepted investors were promulgated, that has had a minimal effect on those countries. It is not a significant advantage. Those countries are still subject to CFIUS review in the vast majority of investments they make. Now, that gives only half the story, because clearly investments from those nations go through a much less rigorous review, and come out with much better results than those from countries where the US has a more strained security relationship.

On what I see in the Bill, I would say a couple of pieces about the excepted possibility. First, as I read the Bill right now, it covers investments from other UK investors—not even simply those outside the UK. If my reading is correct on that front, I have to say that is probably not wise. We have already talked about the significant increase you could have, based to some extent on mandatory transactions as well as some other factors, and I think trying to take a slightly smaller bite of the apple and not including current UK businesses in the scheme would be well advised.

To the extent one has open trade and security relationships with certain countries, lowering the bar for review to exempt them, or including things such as dollar limits and getting rid of the de minimis exemption, might well make sense. That is another way of making sure that the Secretary of State can focus on those areas you think are the most sensitive from a security perspective. Whether we like to do so or not, that can be aligned to some extent with the country of origin of the investor. It is not always perfect—one must often look below that, especially when dealing with limited partners and private equity—but it is a relatively easy way to reduce the load you may experience if all these measures were implemented.

--- Later in debate ---

[Chi Onwurah]

Q Thank you for your response. If we look at GKN-Melrose and, indeed, even SoftBank-Arm, we could consider that they had national security implications. I suppose the point is that there are essential industries that are directly critical for our economy, but that at first may not seem directly critical for national security because they are evolving technologies, as in the case of Arm and the ongoing takeover by Nvidia, or because they are indirectly critical as suppliers to downstream industries that support national security. Indeed, in the response to the Government’s consultation for this Bill, an example is given of the undermining of the functioning of an airport by a software manufacturer, which would be within the transport sector but would not necessarily immediately appear to be directly concerned with national security. Economic security and national security end up being linked. Do you think that should be reflected in the Bill, and how do you think it can be reflected?

David Petrie: I have read the impact assessment, which included that example. It is a difficult situation, as described in the example. In accordance with the way that this new legislation is drafted and the number and extent of the sectors that are regarded as mandatory—the sectors in scope such that their operating activities would require a notification of the unit—the example set out in the impact statement would indeed require screening by the investment security unit. The Government would likely have the opportunity to review a potential acquisition in that software company.

I was struck by that example, in that it suggested that service had failed, or a malign actor had decided not to provide the necessary services to the airport. I think a broader question here is what might happen in reality. Those services would be procured through a commercial contract, which in turn would, presumably, be backed by insurance. If it were an absolutely critical service, I would expect that the airport would have a back-up system, whether power supplies or a parallel running system, as they do for air traffic control. There are commercial protections for the actual operating activities of critical infrastructure, which should work. It is difficult to protect against the actions of malign actors, but critical infrastructure already has systems and processes, and invests heavily in capital equipment, to ensure that there is not an interruption of supply. The question would be the extent to which ownership of that asset physically gave the owners of the shares the ability to get in and interrupt supply. That almost implies mechanical breakdown or some deliberate and malign disconnection. Again, companies have cyber-security systems in place to ensure that critical infrastructure does not fail.

The point you made was about whether suppliers of that sort of service to our critical infrastructure and their ownership should be subject to review. As the Bill is set out and as the sectors in scope are drafted—of course, the Government will consult over the next month or so on those definitions and whether they should be adjusted or whether they are as wide-reaching as they should be—a business like that would be captured. The investment security unit and, presumably, the security services would have an opportunity to review whether or not to allow that to go ahead.

[Nadhim Zahawi]

Q Mr Petrie, you will understand better than most that businesses will want to ensure information is being treated sensitively in any transaction. I want to capture your view of the closed material procedure for judicial review under the Bill and what you think of it in terms of that sensitivity of information.

David Petrie: I think a quasi-judicial review is really important and a part of the process, and then, if necessary, there is judicial review. I think the question cuts back to how many times that is likely to happen. We have to step back a little bit and recognise that that would be a situation where the parties to the transaction are challenging the Secretary of State’s decision as to whether or not this is in the interests of national security.

I would assume that if the sellers are British companies, they will probably have received what they feel are adequate assurances that it is okay to sell to an overseas acquirer, but the Secretary of State takes a different view, presumably based on evidence provided by our national security services. Ultimately, if there is a compelling body of evidence to suggest that a transaction should be modified or adjusted or, in extremis, blocked, it would be quite an unreasonable group of shareholders to disagree with that if the if the Secretary of State was applying the test as set out in the Bill, and indeed in the guidance note, that intervention is to be limited only to matters where the national security of this country is at threat.

That is quite different from the national interest. It is tempting—or possible, rather—in this debate to get sucked into questions about what we should and should not be doing in this country. That is not what this is about. The Government have been very clear to the investment community, and to British business more generally, about the purpose of this legislation. That is why, although markets and investors recognise that it will take a certain amount of time and effort to comply with a mandatory regime—the Government have been very clear about their purpose in introducing that—the market is generally favourably disposed towards it. We can see that it is unfortunately necessary in these modern times.

[Stephen Flynn]

Q Thank you, Mr Petrie, for your answers so far. I just have a couple of straightforward points for you to address. We discussed the timeframe in earlier sessions, in relation to the five years of retrospectivity, the six-month call-in and the potential 75 days. Do you have any concerns about the impact that that might have on potential investors into the UK? On a similar note, in terms of the fact that there will potentially be in excess of 1,800 notifications annually, an entirely new body will have to be set up, possibly working across Departments and involving the security agencies. A lot of detail will need to be put behind that, and again, that will take time. Do you think any of that will cause any uncertainty among investors and perhaps lead them to look elsewhere?

David Petrie: Perhaps I could deal with the second part of your question first, if I may, on the potential number of notifications that the new legislation is going to necessitate. The first point I make about that is that this new investment security unit will need to be very well resourced. A thousand notifications a year is four a day; I am just testing it for reasonableness, as accountants are inclined to do. That is quite a lot of inquiries. I note from the paperwork that the budget allocated to the new unit is between £3.7 million and £10.4 million. I do not know and cannot comment yet as to whether that is likely to be adequate. What I can say is that the impact statement also suggests that of those 1,000 or so transactions which are going to be subject to mandatory notification, only 70 to 95—the numbers set out in the impact statement—are likely to be called in for further review by the Secretary of State, where a very detailed analysis of those businesses and the potential target is going to be necessary.

As, I hope, has been echoed by other witnesses, it is going to be extremely important that this new unit can engage in meaningful pre-consultation with market participants—with British companies, finance directors, and investors and their advisers—so that they can get a pretty clear steer at an early stage as to whether or not this is likely to be subject to further review. If the unit operates in a way where it can give unequivocal guidance to market participants at an early stage and is open to dialogue—I understand from discussions with the Minister that this is the way the unit is being asked to operate—that would be extremely helpful.

I would say that that is about process, certainly, but I think it is also about culture. It has to be a balance, which is well achieved by the Takeover Panel, for example, in this country. You do not tend to approach the Takeover Panel unless you are well-informed and have done your homework—"Don’t bother us with stuff you ought to know” is the unwritten rule. But at the right time and place, I think it is important that there is an opportunity for market participants to be able to engage in a dialogue. The guideline where we put this “Don’t bother us with stuff you ought to know” question is going to shift. At the moment, we really do not know a lot about the way the Government are going to look at certain transactions. We do know which sectors and operating activities are in scope, but, again, we are not quite sure at what stage it will be right to consult and try and get clear guidance. This process will evolve.

I note that the Bill includes provision for the new unit to issue an annual report as to the number of transactions called in and the sectors they are in. That will be extremely helpful for market participants. An issue here, I think, is potentially asymmetry of information. In order to resolve potential asymmetry of information amongst the investment and advisory community, it would be very helpful that the unit is well resourced and able to engage in meaningful pre-consultation, but, by way of a third recommendation, it would also be extremely useful if it was able to issue meaningful market guidance notes, similar to the notes that accompany the takeover code. That would again be extremely helpful so that we can understand. It would help the market to be better informed. If, for example, the unit is receiving a lot of notifications that are not correctly filled in or with important details as to ownership missing, then it would helpful to have guidance notes as to what we can do to make sure this process works with more certainty, speed, clarity and transparency—these are the things financial markets need to see—to help us with that, beyond what has already been issued, which is very helpful, I have to say. As the market evolves, that would be extremely helpful.

--- Later in debate ---

[Chi Onwurah]

Q Thank you very much. I note your suggestion regarding the blanket exception for investment funds. I had two quick follow-up points: first, could you say how they would be defined in such a way that would exclude, for example, foreign sovereign investment funds and so on, which might give cause for concern? Also, you said you had a couple of caveats. I take it that is one; what is your other caveat?

Chris Cummings: Forgive me: I noticed that I missed the point about mergers and acquisitions. We regard the pre-approval facility that officials have mentioned—I believe the last witness mentioned it, as well—which is a way in which the team responsible could be approached ahead of a deal being put together, as a very sensible, practical step forward, as long as confidentiality was absolutely rigorously maintained.

In terms of definitions, we find the Japanese definition quite attractive, and again we commend it to the Committee. It clearly differentiates out investors such as the ones we represent, who are looking to provide capital for a company and share in its success for the benefit of the investors whose money we manage, but are not seeking to take an active role in the management of those companies. We are not looking to put somebody on the board; we are not looking to intervene directly in day-to-day management decisions. Our relationship is with the board chairman and so on, in order to engage in a constructive and strategic discussion, but we stop short of securing assets or taking an active role in management. That is a system that works well.

Turning to our caveats, I mentioned the five-year review period. We undoubtedly recognise the spirit in which this legislation is drafted, but Governments change, as does public opinion. The strength of this Bill is that it is focused around national security. Perhaps a definition of national security may go a little further in helping investors as well, because we could not really strike upon a catchy, well-turned phrase that defined national security, and have a reluctance to move away from national security; we would hate to see the Bill being widened into more public interest ability.

A final point to note would be the interplay between this legislation and the Takeover Panel, which has a different and distinct role to play. The notification percentages are slightly different: it is 25% in the Bill, and 30% in the Takeover Panel, so ensuring that there was no accidental misalignment would be most useful.

[Nadhim Zahawi]

Q Welcome, Mr Cummings. You mentioned the feedback from your members about keeping the Bill focused very much on national security. The message that we want to get out there is that Britain remains very much open for business, and that we want to maintain our place in the premier league of foreign direct investment. How has that statement of policy intent, which we published alongside the Bill, landed with your membership?

Chris Cummings: When it comes to a clarification point around national security, this is similar policy-intent-driven legislation to what we have seen in other emerged markets, such as the US, Germany, France and so on. We do not find that it is out of step with other developed markets. In other jurisdictions—I will take the US as an example—the legislation has started small and then grown as people have become familiar with it. The UK, perhaps because we feel we are playing catch-up—that is not for me to say—has started on a larger scale first. That is why there are queries around scope and around the durations. We look forward to engaging with the definition of the 17 sectors to ensure it is as specific as possible, and to ensure that we understand the operation. We would like to hear from officials and colleagues in ministerial positions on how they see it working in practice, so that the investment community is really clear that the rules of the game have not changed, and that the UK really is as attractive as we want it to be for incoming investment.

As I mentioned, we represent UK-based investment managers, but of course, those organisations are headquartered not only across Europe, but in other parts of the world, particularly the US. We are managing pension scheme money not only for UK savers and pensioners, but from other parts of Europe and places as far-flung as Brazil. If we as investors were looking to make an investment in UK plc, we would need to be clear about where head office was, and where the money was coming from. All those things could be either pre-approved or ruled in court as quickly as possible to ensure that there is not a missed beat in attracting the investment that we all want to see.

[The Chair]

Nickie Aiken.